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One of the perks of working for a personal finance magazine is that my buddies kindly ask me for advice. I always obey, albeit sheepishly, without betraying the fact that I’m still learning (which I freely admit here).For example, the other day I was having lunch with some friends when we started talking about money. The exchange went something like this:
Friend: Ugh, I’m so lost when it comes to money. What should I do?
One of the biggest mistakes young people can make these days (aside from wasting their money on something stupid like a house in Toronto) is not realizing that their money can do more than just sit there.
Me: Well, do you have a TFSA?
Friend: Yes (with a proud voice).
Me: That’s great, you’re ahead of the game. What are you investing in?
Friend: ww-what?
I then proceeded to explain what a TFSA really is. The tax-free savings account is NOT, I repeat, NOT just a savings account.
What is a TFSA?
A tax-free savings account (TFSA) should Yes, really referred to as a tax-free INVESTMENT account. That’s because it’s a registered account, which you can’t just hold savings, but also stocks such as stocks, mutual funds, GICs, bonds and ETFs. Within a TFSA, all of your investments grow tax-free. Another bonus? Unlike a Registered Retirement Savings Account (RRSP), you don’t have to pay taxes when withdrawing funds from your TFSA. That’s right: you don’t pay taxes on growth within your TFSA, and you don’t pay taxes when you take your money out of it.
Who can open a TFSA?
Any Canadian over the age of 18 who has a valid Social Security Number (SIN) is eligible to save or invest in a TFSA.
How do TFSA contributions work?
If you’re asking, “What’s the catch?” – well, there isn’t one unless you count the annual limit on the amount of money you can deposit with the TFSA. The Confederation announces the maximum annual contribution every year; for 2022 it is $6,000 and for 2023 it is $6,500. If you miss a year or don’t make the maximum contribution, your unused contribution space can be carried over to future years. So if you turned 18 before 2009, the first year TFSAs were made available, your current maximum lifetime contribution space is $81,500 (increasing to $88,000 on January 1, 2023). If you withdraw money from your TFSA, that exact amount will be available to you again from the next calendar year. So let’s say you withdraw $4,000 this year to finance a minor home renovation; next year you can deposit the maximum amount advertised for that year, plus the $4,000 you’ve withdrawn this year. (To see more specifically how much you can contribute, enter your numbers in our TFSA Contribution Room Calculator.)
Can I have multiple TFSA accounts?
There is no limit to the number of TFSA accounts a person can have, but your total contribution limit remains the same whether you have one TFSA or six. (The lifetime maximum for those who were 18 or older in 2009 is currently $81,500 and will increase to $88,000 in 2023.) The more accounts you have, the harder it is to keep track. There are penalties for over-contributing, so make sure you never exceed your annual or lifetime limit.
What can I invest in with a TFSA?
You may hold the following qualifying investments within a TFSA:
savings accounts
These are the safest vehicles for investing your money. Because savings accounts are essentially risk-free investments, being insured by the CDIC or similar provincial agency (check with your financial institution for details), even high-yield savings accounts pay a very low rate of return compared to other investments.
Guaranteed Investment Certificates (GICs)
GICs are very safe, low-risk investments with returns that are usually taxed at your marginal income tax rate unless held in a TFSA. GICs guarantee a return for a set period of time, e.g. B. a one-year or five-year term. Non-redeemable GICs pay a higher rate of return in exchange for locking up your money for the entire term. If you feel you may need to access your money before the term expires, you can hold Withdrawable/Redeemable GICs, which allow you to withdraw all or part of your investment at any time – but know you deserve a lower return on these Types of GICs, and all GICs pay a lower rate of return compared to other investments.
Stocks/Equities and Bonds
Investing in the stock market has the potential to generate a substantial return on a small investment. However, stocks and bonds are also subject to high risk. While they can be held in a TFSA, they require both greater financial fitness and risk tolerance than other investment options.
Exchange Traded Funds (ETFs)
An ETF is a basket of investments, usually tied to a specific market index. They can be a mix of different stocks, bonds, commodities, or all together. They’re bought and sold on an exchange, so you’ll need a brokerage account to trade them individually, but they’re also a good complement to automated robo-advisors like Wealthsimple or Questwealth, as they’re designed to be fairly straightforward . ETFs pay a moderate return for a moderate risk, and because they’re not actively managed, they charge relatively low fees. Because ETFs track the stock market as a whole, they are subject to market volatility and are better used as long-term investment vehicles, giving your portfolio a chance to recover from any losses.
Investment funds
Similar to ETFs, these popular mutual funds are diverse collections of stocks, bonds, and commodities. However, rather than passively following the market or a specific index, mutual funds are actively managed by a portfolio manager, through your financial institution, or by a robo-advisor. Because mutual funds are actively managed, they generally have higher fees than stocks or passively managed investments like ETFs. It’s important to look at returns after fees when deciding which funds to invest in. The level of risk and potential reward will vary with the mix of assets held in the fund. Like all investments held in a TFSA, mutual fund income is not taxed. There are many funds to choose from depending on your risk tolerance, and they can be a solid option for long-term investing.
Compare the best TFSA fares in Canada*
What should I use my TFSA for?
The great thing about TFSAs, which is especially helpful for young people with shorter-term savings goals, is that you can withdraw the money at any time without being charged, taxed or levied in any way. Very cute.
I opened a TFSA in high school at my father’s behest. We had witnessed financial difficulties growing up and he didn’t want me to start saving late when he came to Canada in his mid 30’s with family in tow. I bought some mutual funds and contributed $25, then $50 a month from my meager part-time job salary. I can’t say I paid much attention or really cared to the growth I saw. But I felt good because I knew I was doing it some. And it was comforting in my panic at university, when I was certain that I would graduate, then be unemployed and have no income.
I was fortunate that my father taught me the importance of growing my money at that age, so I was aware of the investment power of the tax-free savings account.
If you’re a newbie (like me) and this is new information for you, go ahead and buy some investments! Your TFSA could be growing your money and not just hoarding it for safekeeping.
TFSAs vs. RRSPs: the basics
Both TFSAs and RRSPs are long-term savings vehicles for Canadians that offer some tax protection. With TFSAs, you pay income tax on the money you invest when you earn it, but you don’t pay tax on income earned within or in the TFSA, even if you withdraw it. In contrast, income from RRSP investments is tax-exempt in the year you earn and contribute, but is subject to income tax if deducted as retirement income. RRSPs are a good choice for high earners who anticipate that their retirement income — and thus the tax they end up paying — will be lower than their current income. For others, TFSAs are a better choice.
What are the benefits of a TFSA?
- Tax-free income from investments. These can lead to significant savings in the long term.
- Flexible withdrawal options. You can withdraw as much as you want, whenever you want, with no penalty.
- Rolling Contribution Limits. As long as you have a TFSA in your name, you won’t be penalized for lean years for contributing less or even withdrawing money. This amount will simply accrue so that you can invest in the future.
What are the disadvantages of a TFSA?
- No immediate tax deductions for contributions. If you’re in a high tax bracket and are trying to mitigate your tax burden in a particular year, an RRSP may be a better choice.
- Strict penalties for over-contribution. Even if you accidentally exceed your annual contribution limit, you will be charged a 1% monthly penalty fee.
- If you withdraw money from a TFSA, you will have to wait until the following year to replace that money.
MORE ABOUT TFSAs:
Watch: The differences between TFSA and RRSP
This article was originally published on June 4, 2020and was updated on November 17, 2022.